quick studies

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Solutions Manual, Chapter 23 1291

Chapter 23 Relevant Costing for Managerial Decisions

QUESTIONS

1. The five steps are: (1) define the decision task, (2) identify alternative courses of action, (3) collect relevant information and evaluate each alternative, (4) select the preferred course of action, and (5) analyze and assess decisions made.

2. Nonfinancial information is relevant to decision making because it includes information about such matters as environmental considerations and social responsibility. These issues can have a great effect on a business.

3. A relevant cost is a cost that differs between two alternatives in a decision making process. Relevant costs include out of pocket costs and opportunity costs.

4. Sunk costs are irrelevant because they remain the same whether the product is sold in its present condition or processed further.

5. An out-of-pocket cost requires a current outlay of cash. An opportunity cost is the potential benefit that is lost by choosing an alternative course of action. Opportunity costs are not recorded in the accounting records.

6. Sunk costs are irrelevant because they remain the same whether the product is sold in its present condition or processed further.

7. Some qualitative factors that should be considered in decision making depend on the decision to be made. For instance in a make or buy decision, factors such as quality, delivery time, potential employee layoffs, and reduction in employee morale must be considered. In a special order decision, the company must decide whether the special order is truly a one-time only deal, and whether the company can continue to offer the low price in the long run. Other decisions require the use of other qualitative factors.

8. There are virtually no incremental costs associated with shipping the additional iPod. The company’s employees would not receive any additional compensation for handling one additional item, no ground transportation costs would be incurred for picking it up at the sender’s location, additional fuel costs for transportation would be minuscule, and no additional transportation costs would be incurred at the destination.

9. KTM must consider such factors as: contribution margin lost from the closing of the store and fixed costs saved from the closing. For instance it is possible that a


Financial & Managerial Accounting, 5th Edition 1292

manager who is employed by the store will not be laid off but will be transferred to another store. That person’s salary would not be saved, and so it is not relevant to this decision. KTM must also consider the possibility that they will gain sales at other stores. If a customer transfers their business to another store in the area, that additional contribution margin must be considered as well. There also may be the permanent loss of some customers if it becomes too difficult for them to find a KTM store near them, and they may transfer their business to a competitor.

10. The company might be willing to sell the units internationally if (a) the company has excess capacity, (b) the incremental costs of manufacturing and selling the units are less than $5,000 each, which it appears to be at $4,000 variable cost per unit (c) the international sales won’t reduce domestic sales, and (d) the international buyer is unwilling to pay more than $5,000.



QUICK STUDIES Quick Study 23-1 (5 minutes)

Item Relevant Not relevant

a. Selling price of $6.00 per unit ................................................. X

b. Direct materials cost of $1.00 per unit ................................... X

c. Direct labor of $2.00 per unit .................................................. X

d. Variable manuf. overhead of $1.50 per unit ........................... X

e. Fixed manuf. overhead of $0.75 per unit ............................... X

f. Regular selling expenses of $1.25 per unit ........................... X

g. Additional selling expenses of $0.50 per unit ....................... X

h. Administrative expenses of $0.60 per unit ............................ X

Quick Study 23-2 (10 minutes) Additional operating income if Helix accepts the order

Per unit

Total for 2,000 units

Revenue .................................................................................... $6.00 $12,000

Direct materials ........................................................................ (1.00) (2,000)

Direct labor ............................................................................... (2.00) (4,000)

Variable manufacturing overhead .......................................... (1.50) (3,000)

Additional selling expenses ................................................... (0.50) (1,000)

Operating income from the order ........................................... $1.00 $ 2,000 Based on financial considerations alone, Helix should accept the order.



Quick Study 23-3 (5 minutes) Other factors that Helix should consider before accepting the order are:

Will regular customers demand a lower price if they hear about the special price?

Will this customer become a regular customer and expect the special $6.00 price in the future?

Will this order prevent Helix from accepting business from other customers at the regular price?

Quick Study 23-4 (15 minutes) Revenue if repaired (10,000 x $5) ........................................ $50,000 Revenue if sold as is (10,000 x $2) ...................................... (20,000) Incremental revenue ............................................................. 30,000 Cost to repair ......................................................................... (18,000) Incremental net income if the units are repaired ............... $12,000

Based on this information, Garcia should repair the units. Quick Study 23-5 (5 minutes) 1. F 2. T 3. T 4. T 5. F Quick Study 23-6 (15 minutes)

Incremental cost analysis

Costs of purchasing Cost to purchase Product B ....................................................................... $5.00 Revenue loss from reduced price ($13.50 - $12.00) ................................. 1.50 Total cost ...................................................................................................... 6.50

Savings of purchasing Costs eliminated if Product B purchased ($5 of $9) ................................. 5.00 Net incremental cost of purchasing Product B ........................................ $1.50

Analysis: Kando Co. should continue to manufacture and sell Product A.



Quick Study 23-7 (15 minutes) X Y

Contribution margin per unit .................................................. $ 5.00 $ 4.00 Production hours per unit ....................................................... 1/2 1/3 Contribution margin per production hour ............................. $10.00 $12.00

Sales Mix Analysis: Since Excel Memory can sell all it can produce of both products, it should allocate all of its production capacity to Product Y. This is because Y yields a $12 contribution margin per production hour (versus $10 for X).



Quick Study 23-8 (15 minutes)

INCREMENTAL REVENUE AND COST OF ADDITIONAL PROCESSING

Revenue if processed further (1,250 @ $375) .................................. $468,750

Revenue if sold as is ......................................................................... 67,500

Incremental revenue if processed further ........................................ 401,250

Less incremental cost of processing (1,250 @ $250) ..................... (312,500)

Incremental net income if processed further ................................... $ 88,750

The company should process further as this increases income by $88,750. Quick Study 23-9 (15 minutes)

INCREMENTAL REVENUE AND COST OF REWORK

Revenue if processed further (10,000 @ $110) ................................ $1,100,000

Revenue if sold as is (10,000 @ $30) ................................................ 300,000

Incremental revenue if processed further ........................................ 800,000

Less incremental cost of processing (10,000 @ $80) ..................... 800,000

Incremental net income if reworked ................................................. $ 0

The company should not rework the product as there is no increase in income by doing so.

Quick Study 23-10 (15 minutes)

INCREMENTAL INCOME FROM NEW BUSINESS

Sales (750 units @ $250) ............................................................................. $ 187,500

Incremental variable costs (750 units @ $150) ......................................... (112,500)

Incremental fixed costs ...............................................................................

Incremental income from new business ...................................................

(50,000)

$ 25,000

The company should accept the offer for new business as it increases income by $25,000.



Quick Study 23-11 (15 minutes) Avoidable Unavoidable Expenses Expenses

Cost of goods sold .............................................. $56,000 ----

Direct expenses ................................................... 9,250 $1,250

Indirect expenses................................................. 470 1,600

Service department costs ................................... 6,000 1,430

Total ...................................................................... $71,720 $4,280

The division should not be eliminated because its sales of $72,000 are greater than its avoidable expenses of $71,720. Quick Study 23-12 (10 minutes)

INCREMENTAL INCOME FROM REPLACING MACHINE

Cost to buy new machine ........................................................................... $(112,500)

Cash received to trade in old machine ...................................................... 60,000

Reduction in variable manufacturing costs ..............................................

Incremental income .....................................................................................

60,000

$ 7,500

The company should replace the machine as this increases income by $7,500.



EXERCISES Exercise 23-1 (10 minutes) 1. Sunk cost

2. Relevant benefits

3. Avoidable costs

4. Out-of-pocket cost

5. Opportunity cost Exercise 23-2 (20 minutes)

ALTERNATIVE A: INCREASE OR (DECREASE) IN NET INCOME



Reduction in variable manufacturing costs* ............................................. 85,000

Total change in net income ........................................................................ $ 22,000

*(36,000 - $19,000) X 5 years

ALTERNATIVE B: INCREASE OR (DECREASE) IN NET INCOME



Reduction in variable manufacturing costs** ........................................... 105,000

Total change in net income ........................................................................ $ 32,000

**(36,000 - $15,000) X 5 years

The company should replace the machine with alternative machine B. This will increase net income by $32,000.



Exercise 23-3 (15 minutes) (1) The incremental income from selling as scrap is $55,000 (22,000 x $2.50). (2) INCREMENTAL INCOME FROM REWORK

Sale of reworked units (22,000 units @ $8.50) ......................................... $ 187,000

Less cost to rework units (22,000 @ $4.50) .............................................. (99,000)

Less opportunity cost of not making new units (22,000 @ $2.50)* ........ (55,000)

Incremental income ..................................................................................... $ 33,000

*Sales price per unit – cost per unit = $8.50 - $6 = $2.50.

(3) The product should not be reworked as the $33,000 income from reworking is less than the $55,000 income from selling as is. Exercise 23-4 (25 minutes)

Normal Additional Combined Volume Volume* Total

Sales .................................................. $2,250,000 $180,000 $2,430,000

Costs and expenses

Direct materials .............................. 300,000 30,0001 330,000

Direct labor ..................................... 600,000 60,0002 660,000

Overhead ........................................ 150,000 22,500 172,500

Selling expenses ............................ 225,000 225,000

Administrative expenses .............. 385,500 64,500 450,000

Total costs and expenses ............. $1,660,500 $177,000 $1,837,500

Net income ........................................ $ 589,500 $ 3,000 $ 592,500

1 (15,000 x $2) 2 (15,000 x $4)

* ADDITIONAL VOLUME COMPUTATIONS Additional sales revenue = 15,000 units @ $12 = $180,000 Materials cost per unit = $300,000/150,000 units = $2 per unit Labor cost per unit = $600,000/150,000 units = $4 per unit Incremental overhead = $150,000 x 15% = $22,500 Incremental administrative = $64,500 (given)

RECOMMENDATION: The company should accept the offer because the additional sales would yield an incremental net income of $3,000.



Exercise 23-5 (20 minutes)

Part 1

Normal Additional Combined Volume Volume Total

Sales .................................................. $8,000,000 $1,500,000 $9,500,000

Costs and expenses

Direct materials .............................. 1,000,000 250,000 1,250,000

Direct labor ..................................... 1,200,000 300,000 1,500,000

Variable overhead .......................... 800,000 200,000 1,000,000

Fixed overhead............................... 1,400,000 0 1,400,000

Variable selling and admin. exp. .. 1,120,000 380,000 1,500,000

Fixed selling and admin. exp. ....... 1,040,000 0 1,040,000

Total costs and expenses ............. 6,560,000 1,130,000 7,690,000

Net income ........................................ $1,440,000 $ 370,000 $1,810,000

Calculations: Normal volume sales: 80,000 units x $100 per unit = $8,000,000 Additional revenue from new order: 20,000 units x $75 per unit = $1,500,000 Additional direct materials: 20,000 units x $12.50 per unit = $250,000 Additional direct labor: 20,000 units x $15.00 per unit = $300,000 Additional variable overhead: 20,000 units x $10.00 per unit = $200,000 Additional selling and administrative expense: 20,000 units x ($14 + $5) per unit = $380,000

Based on this analysis, Goshford should accept the new business. Part 2

Other factors that Goshford should consider before deciding whether to accept the new business are:

Will regular customers demand a reduction in their selling price if they hear of the sale to the new customer?

Will the new customer expect to receive the special price for future sales?

If Goshford accepts the new business, it will be operating at full capacity. Can they maintain that full capacity without any defects?

What will happen to regular sales if they cannot meet current customers’ expectations because of this order?




INCREMENTAL COST OF MAKING THE PART

Variable costs (65,000 units @ $1.95) ........................................................ $126,750

Incremental fixed costs ............................................................................... 65,000

Total incremental cost of making 65,000 units ......................................... $191,750

INCREMENTAL COST OF BUYING THE PART

Cost per unit to buy ..................................................................................... $ 3.50

Total incremental cost of buying 65,000 units .......................................... $227,500

RECOMMENDATION: Note that the allocated fixed costs of $58,500 are not relevant to this managerial decision because they will continue whether the part is made or bought. Therefore, the incremental costs of making the part are $35,750 less per year than buying it. This implies that the company should continue to make this part. Note: We should recognize that this decision depends on the alternative uses for the productive facilities dedicated to making the part. If they can be used to produce a profit greater than the $37,500 annual savings that the company attains by making this part, the part should probably be purchased and the facilities used for the other more profitable activities.




INCREMENTAL COST OF MAKING THE PART

Variable costs (40,000 units x $1.95) .......................................................... $ 78,000

Incremental fixed costs ............................................................................... 65,000

Total incremental cost of making 40,000 units ......................................... $143,000



Total incremental cost of buying 40,000 units .......................................... $140,000

RECOMMENDATION: Note that the allocated fixed costs of $58,500 are not relevant to this managerial decision because they will continue whether the part is made or bought. Therefore, the incremental costs of making the part are $3,000 more per year than buying it. This implies that the company should buy this part from the outside supplier.





Revenue if processed further* ........................................................... $1,372,000

Revenue if sold as is .......................................................................... 700,000

Incremental revenue ........................................................................... 672,000

Less incremental cost of processing ............................................... 420,000

Incremental net income ...................................................................... $ 252,000

*Revenue from processed products Units Price Total

Product B .............................................................................. 5,600 $105 $ 588,000 Product C .............................................................................. 11,200 70 784,000 Total revenue from processed products ............................ $1,372,000 ALTERNATE SOLUTION FORMAT

Net income (loss) from processed products Revenue if processed further................................................ $1,372,000 Less: Additional costs of processing................................. $(420,000) Opportunity cost (lost sales of Product A) ............... (700,000) (1,120,000)

Net benefit to processing ...................................................... $ 252,000

RECOMMENDATION: This analysis shows that the company will be better off by $252,000 if it chooses to process Product A into the two products of B and C. (Note that the $28 per unit cost of manufacturing Product A is sunk and irrelevant to this decision.)

Exercise 23-9 (minutes)


Revenue if processed further (7,000 x $25) ............................................... $175,000

Revenue if sold as is (7,000 x $8) ............................................................... 56,000

Incremental revenue .................................................................................... 119,000

Less incremental cost of processing ......................................................... 125,000

Incremental net income ............................................................................... $ (6,000)

RECOMMENDATION: Varto should not process these units further, as they will be $6,000 worse off if they do so. (Note that the $22 per unit manufacturing cost is not relevant because it is a sunk cost.)




Instructor note: In all three cases, the total unavoidable expenses of $107,800 remain the same because they cannot be avoided by eliminating departments.

1. NO DEPARTMENTS ELIMINATED Total M N O P T

Sales................................. $224,000 $63,000 $35,000 $56,000 $42,000 $28,000 Expenses Avoidable ....................... 120,400 9,800 36,400 22,400 14,000 37,800 Unavoidable ................... 107,800 51,800 12,600 4,200 29,400 9,800 Total expenses .............. 228,200 61,600 49,000 26,600 43,400 47,600 Net income (loss) ............ $ (4,200) $ 1,400 $(14,000) $29,400 $ (1,400) $(19,600)

2. DEPARTMENTS WITH EXPECTED NET LOSSES ELIMINATED Total M N O P T

Sales...................................................... $119,000 $63,000 $ 0 $56,000 $ 0 $ 0

Expenses

Avoidable ............................................ 32,200 9,800 0 22,400 0 0

Unavoidable ........................................ 107,800 51,800 12,600 4,200 29,400 9,800

Total expenses ................................... 140,000 61,600 12,600 26,600 29,400 9,800

Net income (loss) ................................. $ (21,000) $ 1,400 $(12,600) $29,400 $(29,400) $(9,800)

Explanation: This income statement reflects elimination of Departments N, P, and T. The sales and avoidable expenses are the combined amounts for Departments M and O. The net loss has actually increased because the excess of sales dollars over avoidable expenses has declined and less remains to cover unavoidable expenses. 3. DEPARTMENTS WITH LESS SALES THAN AVOIDABLE EXPENSES ELIMINATED Total M N O P T

Sales...................................................... $161,000 $63,000 $ 0 $56,000 $42,000 $ 0

Expenses

Avoidable ............................................ 46,200 9,800 0 22,400 14,000 0

Unavoidable ........................................ 107,800 51,800 12,600 4,200 29,400 9,800

Total expenses ................................... 154,000 61,600 12,600 26,600 43,400 9,800

Net income (loss) ................................. $ 7,000 $ 1,400 $(12,600) $29,400 $ (1,400) $(9,800)

Explanation: This income statement reflects the Departments M, O, and P. Departments N and T are eliminated because their sales dollars do not cover their avoidable costs.



Exercise 23-11 (15 minutes) If canoes are discontinued

Revenue lost ................................................................... $2,000,000

Variable costs saved

Direct materials ............................................................ $450,000

Direct labor ................................................................... 500,000

Variable overhead ........................................................ 300,000

Variable selling & administrative ............................... 200,000

Total variable costs saved ............................................ 1,450,000

Contribution margin lost ............................................... 550,000

Direct fixed costs saved ................................................ 375,000

Income lost ..................................................................... $ 175,000

Based on the above analysis, the canoes should not be discontinued. Exercise 23-12 (30 minutes)

Preliminary computations

Contribution margin per hour Product TLX Product MTV

Selling price per unit ................................................. $15.00 $ 9.50 Variable costs per unit .............................................. 4.80 5.50 Contribution per unit ................................................. $10.20 $ 4.00

Machine-hours to produce 1 unit ............................. 0.50 0.20 Contribution margin per machine-hour (or contribution/hours per unit) .............................. $20.40 $20.00

1. FOR PRODUCT TLX

Maximum sales ........................................................................ 4,700 units Hours needed per unit ............................................................ 0.50 Total hours used (4,700 x 0.50) .............................................. 2,350 hours

FOR PRODUCT MTV

Remaining hours (2,750 – 2,350)............................................ 400 hours Hours needed per unit ............................................................ 0.20 Maximum production* (400/0.20) ........................................... 2,000 units *Below market maximum production.



Exercise 23-12 (continued)

SALES MIX RECOMMENDATION: These results suggest the company should manufacture as many units of Product TLX as it can produce and sell until reaching a (market or production) constraint. Thereafter, any remaining capacity should be devoted to Product MTV, up to the maximum that can be produced and/or sold.

2. CONTRIBUTION MARGIN FROM THE RECOMMENDED SALES MIX

Units

Contribution per Unit

Total

Product TLX ...................................... 4,700 $10.20 $47,940 Product MTV ..................................... 2,000 4.00 8,000 Total ................................................... $55,940


K1 S5 G9

Selling price per unit ..................................................... $160 $112 $210

Variable costs per unit .................................................. 96 85 144

Contribution margin per unit ........................................ 64 27 66

Pounds of material required ......................................... ÷ 4 ÷ 3 ÷ 6

Contribution margin per pound .................................... $ 16 $ 9 $ 11

Childress should produce and fill orders for K1 first because it has the highest contribution margin per pound of materials. Production and orders for G9 should be addressed second, and production and orders for S5 should be addressed third.



PROBLEM SET A Problem 23-1A (45 minutes)

JONES PRODUCTS COMPARATIVE INCOME STATEMENTS

(1) (2) (3)

Normal New Volume Business Combined

Sales ............................................................ $2,400,000 $260,000 $2,660,000

Costs and expenses

Direct materials ........................................ 576,000 72,000 648,000

Direct labor ............................................... 144,000 27,000 171,000

Overhead .................................................. 320,000 30,000 350,000

Selling expenses ...................................... 150,000 150,000

Administrative expenses ........................ 100,000 5,000 105,000

Total costs & expenses ............................. 1,290,000 134,000 1,424,000

Operating income ...................................... $1,110,000 $126,000 $1,236,000

Supporting computations

Normal direct materials cost ........................................ $576,000 Units of output ............................................................... 400,000 Cost per unit .................................................................. $ 1.44 New business volume ................................................... 50,000 New business direct materials cost ............................. $ 72,000 Normal direct labor cost ............................................... $144,000 Units of output ............................................................... 400,000 Cost per unit .................................................................. $ 0.36 Overtime per unit (50%) ................................................ 0.18 New business direct labor cost per unit ...................... $ 0.54 New business volume ................................................... 50,000 New business direct labor cost .................................... $ 27,000 Total overhead ............................................................... $320,000 Fixed overhead (25%) ................................................... 80,000 Variable overhead ......................................................... $240,000 Units of output ............................................................... 400,000 Cost per unit .................................................................. $ 0.60 New business volume ................................................... 50,000 New business variable overhead cost ......................... $ 30,000



Problem 23-2A (50 minutes)

Part 1

CALLA COMPANY COMPARATIVE INCOME STATEMENTS

(a) (b) (c)


Sales .................................................. $4,000,000 $450,000 $4,450,000

Costs and expenses


Direct labor ..................................... 640,000 80,000 720,000

Overhead ........................................ 960,000 84,000 1,044,000

Selling expenses ............................ 560,000 62,000 622,000

Administrative expenses .............. 480,000 1,000 481,000

Total costs and expenses ............... 3,440,000 327,000 3,767,000

Operating income ............................ $ 560,000 $123,000 $ 683,000


Normal sales revenue (80,000 x $50) ........................... $4,000,000 New business sales revenue (10,000 x $45) ................ $ 450,000 Normal direct materials cost ........................................ $ 800,000 Units of output ............................................................... 80,000 Cost per unit .................................................................. $ 10.00 New business volume ................................................... 10,000 New business direct materials cost ............................. $ 100,000 Normal direct labor cost ............................................... $ 640,000 Units of output ............................................................... 80,000 Cost per unit .................................................................. $ 8.00 New business volume ................................................... 10,000 New business direct labor cost .................................... $ 80,000



Problem 23-2A (concluded)

Total overhead ............................................................... $ 960,000 Fixed overhead (30%) ................................................... 288,000 Variable overhead ......................................................... $ 672,000 Units of output ............................................................... 80,000 Cost per unit .................................................................. $ 8.40 New business volume ................................................... 10,000 New business variable overhead cost ......................... $ 84,000 Total selling expenses .................................................. $ 560,000 Fixed selling expenses (40%) ....................................... 224,000 Variable selling expenses ............................................. 336,000 Units of output ............................................................... 80,000 Cost per unit .................................................................. $ 4.20 Plus additional selling expenses per unit ................... 2.00 Total selling cost per unit for this order ...................... $ 6.20 New business volume ................................................... 10,000 New business selling expenses ................................... $ 62,000

Part 2 Based on the financial analysis above, Calla should accept the order. The order provides additional income of $123,000. Other factors that Calla should consider are:

Will the customer expect additional skateboards at this special price?

Will regular customers demand a reduction in their price?

Can Calla maintain quality and production at full capacity? Part 3 If the new customer demands 15,000 units instead of 10,000, this will mean that Calla will lose sales of 5,000 units at the regular price. They will have to consider the contribution margin lost on these units, as well as whether their regular customers will go elsewhere to obtain their skateboards. This could lead to a permanent loss of volume at the regular price of $50 per unit.



Problem 23-3A (30 minutes) Part 1

INCREMENTAL COST OF MAKING RX5

Variable costs:

Direct materials (50,000 units x $5.00 per unit) ............................ $250,000

Direct labor (50,000 units x $8.00 per unit) ................................... 400,000

Variable overhead ($450,000* x 20%) ............................................ 90,000

Total incremental cost of making 50,000 units ............................... $740,000

* Total overhead = 50,000 units x $9.00 per unit = $450,000


Cost per unit to buy ........................................................................... $ 18.00

Total incremental cost of buying 50,000 units ................................ $900,000

Haver is better off making RX5. Part 2 Other factors Haver should consider besides cost are:

Will the supplier provide the quality that Haver needs?

Will the supplier provide the RX5 on a timely basis?

Will the supplier’s cost remain at $18 per unit or will it go up or down?

What can Haver do in the space that is now used to produce RX5? Can they produce something that will provide additional income?



Problem 23-4A (30 minutes) Alternative 1: Sell to a second-hand shop

Incremental revenue (5,000 x $6.00) ........................................................... $ 30,000 Incremental cost ........................................................................................... 0 Incremental income ...................................................................................... $ 30,000 Alternative 2: Disassemble and sell to a recycler

Incremental revenue (5,000 x $12.00) ......................................................... $ 60,000 Incremental cost ........................................................................................... 32,000 Incremental income ...................................................................................... $ 28,000 Alternative 3: Rework and sell at regular prices

Incremental revenue (3,000 x $45.00) ......................................................... $135,000 Incremental cost ........................................................................................... 102,000 Incremental income ...................................................................................... $ 33,000 Decision: Harold should choose alternative 3, as this provides the highest incremental income.




Product G Product B

Selling price per unit ..................................................... $120 $160

Variable costs per unit .................................................. 40 90

Contribution margin per unit ........................................ $ 80 $ 70

Machine hours to produce 1 unit ................................. 0.4 1.0

Contribution per machine hour (or contribution/[hours per unit]) .............................. $200 $ 70

Part 2 Sales Mix Recommendation. To the extent allowed by production and market constraints, the company should produce as much of Product G as possible. With a single shift yielding 176 hours per month (8 x 22), the company can produce these units of Product G: Maximum output of G = = 440 units per month Contribution Margin at Recommended Sales Mix Contribution margin = 440 units x $80 per unit = $35,200 per month

176 hrs. per mo.

0.4 hrs. per unit



Problem 23-5A (Continued)

Part 3 Sales Mix Recommendation with Second Shift. If the second shift is added, the maximum possible output of G will double Maximum possible output of G = = 880 units per mo. However, this level of output exceeds the company’s market constraint of 600 units of G per month. This means the company should produce 600 units of Product G, and commit the remainder of the productive capacity to Product B. This is computed as follows Units of Product G ............................................................... = 600 units per month

Hours per unit ...................................................................... 0.4 Hours used for Product G .................................................. 240 hours

Hours available for Product B (352 hrs - 240 hrs) ................... 112 hours The output of Product B with 112 production hours is Units of Product B = = 112 units per month Contribution Margin at This Sales Mix

Units Contr./unit Total

From G .................................................................. 600 $80 $48,000 From B .................................................................. 112 70 7,840 Less extra shift costs .......................................... (15,000) Total contribution margin ................................... $40,840 Management decision. The contribution margin of $40,840 exceeds the contribution margin of $35,200 generated by one shift alone (see part 2). Therefore, management should add the second shift.

352 hrs. per mo.

0.4 hrs. per unit

112 hrs. per mo.

1 hr. per unit



Problem 23-5A (Continued) Part 4 Sales Mix Recommendation. By incurring additional marketing cost, the company can relax the market constraint for sales of Product G up to the point where 700 units can be sold. This means the company can produce 700 units of Product G, and commit the remainder of its productive capacity, if any, to Product B. These computations are Units of Product G ............................................................... = 700 units per month

Hours per unit ...................................................................... 0.4 Hours used for Product G .................................................. 280 hours Hours available for Product B (352 hrs - 280 hrs) .................. 72 hours The output of Product B with 72 production hours is Units of Product B = = 72 units per month Contribution Margin at This Sales Mix


From G ................................................................... 700 $80 $56,000 From B ................................................................... 72 70 5,040 Less extra shift costs ........................................... (15,000) Less extra marketing costs ................................. (12,000) Total contribution margin .................................... $34,040 Management decision. This contribution margin of $34,040 is less than the contribution margin of $40,840 generated under the existing market constraint (see part 3). Therefore, the marginal benefits generated do not warrant the marketing efforts.

72 hrs. per mo.

1 hr. per unit




ELEGANT DECOR COMPANY Analysis of Expenses under Elimination of Department 200

Total Eliminated Continuing Expenses Expenses Expenses

Cost of goods sold .............................................. $469,000 $207,000 $262,000

Direct expenses

Advertising ......................................................... 29,000 12,000 17,000

Store supplies used ........................................... 7,800 3,800 4,000

Depreciation—Store equipment ....................... 8,300 8,300

Allocated expenses

Sales salaries* .................................................... 104,000 52,000 52,000

Rent expense...................................................... 14,160 14,160

Bad debts expense ............................................ 18,000 8,100 9,900

Office salary* ...................................................... 31,200 31,200

Insurance expense* ........................................... 3,100 770 2,330

Miscellaneous office expenses* ....................... 4,000 400 3,600

Total expenses ..................................................... $688,560 $284,070 $404,490

*Computation notes. Closing Department 200 will eliminate 70% of its insurance expense and 25% of its miscellaneous office expense. Sales salaries will be reduced by the amounts paid to the two clerks who will not be replaced. The office salary will not be eliminated, but it will be reclassified so that one-half will be reported as sales salary and one-half as office salary.



Problem 23-6A (Continued)

Part 2

ELEGANT DECOR COMPANY Forecasted Annual Income Statement

Under Plan to Eliminate Department 200

Sales ......................................................................................................... $436,000

Cost of goods sold ................................................................................. 262,000

Gross profit from sales .......................................................................... 174,000

Operating expenses

Advertising ............................................................................................ 17,000

Store supplies used ............................................................................. 4,000

Depreciation of store equipment ........................................................ 8,300

Sales salaries ........................................................................................ 67,600*

Rent expense ........................................................................................ 14,160

Bad debts expense ............................................................................... 9,900

Office salary .......................................................................................... 15,600*

Insurance expense ............................................................................... 2,330

Miscellaneous office expenses ........................................................... 3,600

Total operating expenses ...................................................................... 142,490

Net income ............................................................................................... $ 31,510

* Administrative salary reassignment

Total Sales Office

Salaries Salaries Salary

Salesclerks ........................................................................ $52,000 $52,000 Administrative worker ....................................................... 31,200 $31,200 Reassign admin. worker to sales ..................................... 0 15,600 (15,600) Revised salaries ................................................................ $83,200 $67,600 $15,600



Problem 23-6A (Continued) Part 3

ELEGANT DECOR COMPANY

Reconciliation of Combined Income With Forecasted Income

Combined net income ......................................................................... $ 37,440

Less Dept. 200's lost sales .................................................................. (290,000)

Plus Dept. 200’s eliminated expenses ............................................... 284,070

Forecasted net income ........................................................................ $ 31,510

ANALYSIS

Department 200's avoidable expenses of $284,070 are $5,930 less than its

revenues of $290,000. This means the company's annual net income would

be $5,930 less from eliminating Department 200. This analysis suggests

the department should probably not be eliminated.



PROBLEM SET B Problem 23-1B (45 minutes)

WINDMIRE COMPANY COMPARATIVE INCOME STATEMENTS

(1) (2) (3)


Sales ............................................................ $1,200,000 $172,000 $1,372,000

Costs and expenses

Direct materials ........................................ 384,000 64,000 448,000

Direct labor ............................................... 96,000 24,000 120,000

Overhead .................................................. 288,000 36,000 324,000

Selling expenses ...................................... 120,000 120,000

Administrative expenses ........................ 80,000 4,000 84,000

Total costs and expenses ......................... 968,000 128,000 1,096,000

Operating income ...................................... $ 232,000 $ 44,000 $ 276,000


Normal direct material cost ..................................................... $384,000 Units of output .......................................................................... 300,000 Cost per unit ............................................................................. $ 1.28 New business volume .............................................................. 50,000 New business direct material cost .......................................... $ 64,000 Normal direct labor cost .......................................................... $ 96,000 Units of output .......................................................................... 300,000 Cost per unit ............................................................................. $ 0.32 Overtime per unit (50%) ........................................................... 0.16 New business direct labor cost per unit ................................. $ 0.48 New business volume .............................................................. 50,000 New business direct labor cost ............................................... $ 24,000 Total overhead .......................................................................... $288,000 Fixed overhead (25%) .............................................................. 72,000 Variable overhead .................................................................... $216,000 Units of output .......................................................................... 300,000 Cost per unit ............................................................................. $ 0.72 New business volume .............................................................. 50,000 New business variable overhead cost .................................... $ 36,000



Problem 23-2B (50 minutes) Part 1

MERVIN COMPANY COMPARATIVE INCOME STATEMENTS

(a) (b) (c)


Sales .................................................. $4,400,000 $300,000 $4,700,000

Costs and expenses


Direct labor ..................................... 1,100,000 100,000 1,200,000

Overhead ........................................ 1,375,000 100,000 1,475,000

Selling expenses ............................ 275,000 20,000 295,000

Administrative expenses .............. 550,000 700 550,700

Total costs & expenses ................... 4,125,000 295,700 4,420,700

Operating income ............................ $ 275,000 $ 4,300 $ 279,300


Normal sales revenue (550,000 x $8) ........................... $4,400,000 New business sales revenue (50,000 x $6) .................. $ 300,000 Normal direct materials cost ........................................ $ 825,000 Units of output ............................................................... 550,000 Cost per unit .................................................................. $ 1.50 New business volume ................................................... 50,000 New business direct materials cost ............................. $ 75,000 Normal direct labor cost ............................................... $1,100,000 Units of output ............................................................... 550,000 Cost per unit .................................................................. $ 2.00 New business volume ................................................... 50,000 New business direct labor cost .................................... $ 100,000



Problem 23-2B (concluded)

Total overhead ............................................................... $1,375,000 Fixed overhead (20%) ................................................... 275,000 Variable overhead ......................................................... $1,100,000 Units of output ............................................................... 550,000 Cost per unit .................................................................. $ 2.00 New business volume ................................................... 50,000 New business variable overhead cost ......................... $ 100,000 Total selling expenses .................................................. $ 275,000 Fixed selling expenses (60%) ....................................... 165,000 Variable selling expenses ............................................. 110,000 Units of output ............................................................... 550,000 Cost per unit .................................................................. $ 0.20 Plus additional selling expenses per unit ................... 0.20 Total selling cost per unit for this order ...................... $ 0.40 New business volume ................................................... 50,000 New business selling expenses ................................... $ 20,000

Part 2 Based on the financial analysis above, Mervin should accept the order. The order provides additional income of $4,300. Other factors that Mervin should consider are:

Will the customer expect additional circuit boards at this special price?

Will regular customers demand a reduction in their price?

Can Mervin maintain quality and production at full capacity? Part 3 If the new customer demands 100,000 units instead of 50,000, this will mean that Mervin will lose sales of 50,000 units at the regular price. They will have to consider the contribution margin lost on these units, as well as whether their regular customers will go elsewhere to obtain their circuit boards. This could lead to a permanent loss of volume at the regular price of $8 per unit.




INCREMENTAL COST OF MAKING TH1

Variable costs:

Direct materials (400,000 units x $1.20 per unit) .................................... $ 480,000

Direct labor (400,000 units x $1.50 per unit) ........................................... 600,000

Variable overhead (2,400,000* x 25%) ..................................................... 600,000

Total incremental cost of making 50,000 units ......................................... $1,680,000

* Total overhead = 400,000 units x $6 per unit = $2,400,000



Total incremental cost of buying 400,000 units ........................................ $1,600,000

Alto is better off buying the TH1 from the outside supplier. Part 2 Other factors Alto should consider besides cost are:

Will the supplier provide the quality that Alto needs?

Will the supplier provide the TH1 on a timely basis?

Will the supplier’s cost remain at $4 per unit or will it go up or down?

What can Alto do in the space that is now used to produce TH1? Can they produce something that will provide additional income?



Problem 23-4B (45 minutes)

Alternative 1: Sell to a wholesaler

Incremental revenue (7,500 x $75.00) ......................................................... $ 562,500 Incremental cost ........................................................................................... 0 Incremental income ...................................................................................... $ 562,500 Alternative 2: Disassemble and sell to a recycler

Incremental revenue (7,500 x $130.00) ....................................................... $ 975,000 Incremental cost ........................................................................................... 400,000 Incremental income ...................................................................................... $ 575,000 Alternative 3: Rework and sell at regular prices

Incremental revenue (7,500 x $500.00) ....................................................... $3,750,000 Incremental cost ........................................................................................... 3,200,000 Incremental income ...................................................................................... $ 550,000 Decision: Micron should choose alternative 2, as this provides the highest incremental income.




Product R Product T

Selling price per unit ..................................................... $ 60 $ 80


Contribution margin per unit ........................................ $ 40 $ 35

Machine hours to produce 1 unit ................................. 0.4 1.0

Contribution per machine hour (or contribution/[hours per unit]) .............................. $100 $ 35

Part 2 Sales Mix Recommendation To the extent allowed by production and market constraints, the company should produce as much of Product R as possible. With a single shift yielding 176 hours per month (8 x 22), the company can produce these units of Product R: Maximum output of R = = 440 units per month Contribution Margin at Recommended Sales Mix Contribution margin = 440 units x $40 per unit = $17,600 per month

176 hrs. per mo.

0.4 hrs. per unit



Problem 23-5B (Continued) Part 3 Sales Mix Recommendation with Second Shift If the second shift is added, the maximum possible output of R will double: Maximum possible output of R = = 880 units per mo. However, this level of output exceeds the company’s market constraint of 550 units of Product R per month. This means the company should produce 550 units of Product R, and commit the remainder of the productive capacity to Product T. This is computed as follows: Units of Product R ............................................................ = 550 units per month Hours per unit ................................................................... 0.4 Hours used for Product R ................................................ 220 hours

Hours available for Product T (352 hrs - 220 hrs) ................. 132 hours The output of Product T with 132 production hours is Units of Product T = = 132 units per month

Contribution Margin at This Sales Mix


From R .................................................................. 550 $40 $22,000 From T .................................................................. 132 35 4,620 Less extra shift costs .......................................... (3,250) Total contribution margin ................................... $23,370 Management decision This amount of $23,370 exceeds the contribution margin of $17,600 generated by one shift alone (see part 2). Therefore, management should add the second shift.

352 hrs. per mo.

0.4 hrs. per unit

132 hrs. per mo.

1.0 hrs. per unit



Problem 23-5B (Continued) Part 4 Sales Mix Recommendation By incurring additional marketing cost, the company can relax the market constraint for sales of Product R up to the point where 675 units can be sold. This means the company can produce 675 units of Product R, and commit the remainder of its productive capacity to Product T. These computations are: Units of Product R ............................................................ = 675 units per month Hours per unit ................................................................... 0.4 Hours used for Product R ................................................ 270 hours Hours available for Product T (352 hrs less 270 hrs) ....................................................

82

hours

The output of Product T with 82 production hours is Units of Product T = = 82 units per month

Contribution Margin with This Sales Mix


From R .................................................................. 675 $40 $27,000 From T .................................................................. 82 35 2,870 Less extra shift costs .......................................... (3,250) Less extra marketing costs ................................ (4,500) Total contribution margin ................................... $22,120 Management decision This amount of $22,120 is less than the contribution margin of $23,370 generated under the existing market constraint (see part 3). Therefore, management should not undertake this marketing strategy.

82 hrs. per mo.

1.0 hr. per unit




ESME COMPANY Analysis of Expenses under Elimination of Department Z

Total Eliminated Continuing Expenses Expenses Expenses

Cost of goods sold .............................................. $586,400 $125,100 $461,300

Direct expenses

Advertising ......................................................... 30,000 3,000 27,000

Store supplies used ........................................... 7,000 1,400 5,600

Depreciation of store equip. ............................. 21,000 21,000

Allocated expenses

Sales salaries* .................................................... 93,600 46,800 46,800

Rent expense...................................................... 27,600 27,600

Bad debts expense ............................................ 25,000 4,000 21,000

Office salary* ...................................................... 26,000 26,000

Insurance expense* ........................................... 5,600 910 4,690

Miscellaneous office expenses* ....................... 4,200 750 3,450

Total expenses ..................................................... $826,400 $181,960 $644,440

Computation Notes Closing Department Z will eliminate 65% of its insurance expense and 30% of its miscellaneous office expense. Sales salaries will be reduced by the amounts paid to the two clerks who will not be replaced. The office salary will not be eliminated, but it will be reclassified so that one-half will be reported as sales salary and one-half as office salary.



Problem 23-6B (Continued) Part 2

ESME COMPANY Forecasted Annual Income Statement Under Plan to Eliminate Department Z

Sales ...................................................................................................... $700,000

Cost of goods sold .............................................................................. 461,300

Gross profit from sales ....................................................................... 238,700

Operating expenses

Advertising ......................................................................................... 27,000

Store supplies used .......................................................................... 5,600

Depreciation of store equipment ..................................................... 21,000

Sales salaries ..................................................................................... 59,800*

Rent expense ..................................................................................... 27,600

Bad debts expense ............................................................................ 21,000

Office salary ....................................................................................... 13,000*

Insurance expense ............................................................................ 4,690

Miscellaneous office expenses ........................................................ 3,450

Total operating expenses ................................................................... 183,140

Net income ............................................................................................ $ 55,560

* Office salary reassignment

Total Sales Office

Salaries Salaries Salary

Sales clerks ....................................................................... $46,800 $46,800 Office clerk ........................................................................ 26,000 $26,000 Reassign office clerk to sales .......................................... 0 13,000 (13,000) Revised salaries................................................................ $72,800 $59,800 $13,000



Problem 23-6B (Continued) Part 3

ESME COMPANY

Reconciliation of Combined Income with Forecasted Income

Combined net income ........................................................................... $ 48,600

Less Dept. Z's lost sales ........................................................................ (175,000)

Plus Dept. Z’s eliminated expenses ...................................................... 181,960

Forecasted net income ........................................................................... $ 55,560

ANALYSIS

Department Z's avoidable expenses of $181,960 are $6,960 greater than its

revenues of $175,000. This means the company's annual net income would

be $6,960 higher from eliminating Department Z. This analysis suggests

management should probably go ahead with the elimination of the

department as planned.



SERIAL PROBLEM — SP 23 Serial Problem, Success Systems (50 minutes)

Desks Chairs

Selling price per unit ............................................................... $ 1,125 $ 375

Variable costs per unit ............................................................ 500 200

Contribution margin per unit .................................................. $ 625 $ 175

Direct labor hours to produce 1 unit ...................................... 5 4

Contribution per direct labor hour ......................................... $125.00 $43.75

As the desks have the highest contribution margin per direct labor hour used, Adria should fill all of the orders for the desks first, and then fill as many of the orders for the chairs as she can. Orders for desks ....................................................................... 175

Direct labor hours required per desk ..................................... 5

Total direct labor hours used for desks ................................. 875

Total direct labor hours available ........................................... 1,015

Hours available to produce chairs.......................................... 140

Direct labor hours required per chair ..................................... 4

Chairs that can be produced in that time .............................. 35 Therefore, Adria should produce 175 desks and 35 chairs. Her contribution margin for that level is:

Desks Chairs Total

Sales ...................................................................... $196,875 $13,125 $210,000 Variable costs....................................................... 87,500 7,000 94,500 Contribution margin ............................................ $109,375 $ 6,125 $115,500

Calculations: Sales of desks: 175 x $1,125 = $196,875 Sales of chairs: 35 x $375 = $13,125 Variable costs, desks: 175 x $500 = $87,500 Variable costs, chairs: 35 x $200 = 7,000



Reporting in Action — BTN 23-1

1.

$ millions Off-road Snow On-road

Revenues .................................................... $1,823 $280 $146

Operating expenses................................... 1,586 294 140

Operating income ...................................... $ 237 $ (14) $ 6

2. If the results in Part 1 are typical, then Polaris might decide to eliminate

the Snowmobile segment. Its operating expenses are higher than its

revenues.



Comparative Analysis — BTN 23-2

1. Answer depends on the newspaper selected and its price for advertising

space. The cost of one full-page advertisement in a medium-sized U.S.

city newspaper is probably near $8,000.

2. If we assume that the average product of Polaris and Arctic Cat sells for

around $12,000, then the contribution margin per product is about

$2,400 (using the 20% stated assumption in the problem). This would

mean that the company would need to sell at least 4 additional products

(computed by dividing the $8,000 advertisement by the $2,400

contribution margin per product, rounded up) to recover the price of the

advertisement. Incremental sales of 4 products or more from this

advertisement would support the profitability of this marketing strategy.

If the companies’ average selling prices are higher (lower) than $12,000,

then fewer (more) units would have to be sold to recover the price of the

advertisement.

3.

MEMORANDUM TO: FROM: DATE: SUBJECT:

Primary points for discussion of the importance of effective advertising:

(a) Students need to recognize that advertising is very expensive

and crucial to most merchandisers. (b) The students should also recognize that an advertisement

must be effective to justify its cost and the related product mix decision of managers.

(c) In most cases the advertisement must generate several

thousand dollars in sales to pay for the advertisement.



Ethics Challenge — BTN 23-3 1 and 2.

Per controller Per Asiago

Selling price ......................................................... $ 40 $ 40 Variable costs ....................................................... 42 40 Contribution margin ............................................. $ (2) $ 0

3. Whether the company should take the order depends on several factors:

Asiago is eager to obtain a new customer. However, will the customer expect that the selling price of the product will remain at $40? If so, is Asiago willing to accept a commission one-half of his regular commission? Is the company willing to accept a sale with a zero contribution margin?

Will regular customers hear about this special price and demand that their price be reduced as well? If they do, Convertco may not be able to meet this demand and still make an overall profit. After all, companies must cover their fixed costs as well as their variable costs in order to make a profit.

Communicating in Practice — BTN 23-4

MEMORANDUM TO: Manager FROM: Student DATE: SUBJECT: Considerations when deciding whether to drop the hardware department It is important to understand fully the consequences of dropping a department. Many factors need to be taken into account. These include:

What is the contribution margin of the department? If it is positive it is contributing something to cover the overall fixed costs of the entire store.

Will there be any fixed costs saved if the department is closed? That will increase overall store income.

What can we do with the space that is now being used for the hardware department? Can we expand a more profitable department?

Will dropping the hardware department affect sales in other departments? Will customers who need hardware and other items go elsewhere instead of Greeble’s?



Taking It to the Net — BTN 23-5 1. According to Bizbrim, the business processes typically outsourced are

“backend” jobs like call/help centers, medical transcription, billing, payroll processing, and data entry.

2. Companies who are outsourcing their business processes are able to recruit more labor at lower prices than they otherwise could. This enables these companies to lower their costs and generate higher profits. Business process outsourcing also benefits “third world” countries by generating good jobs.



Teamwork in Action — BTN 23-6 Instructor note: Answers will vary across students. Yet the examples, while different, should capture similar qualitative factors.

Cost item

Variable or Fixed?

Likely to be saved if flight is dropped?

Rationale

Salaries of flight attendants

Fixed No If the flight is dropped, these flight attendants are likely to be transferred to other flights. It is possible in the long run to reduce the total number of flight attendants if the flight is permanently dropped.

Salaries of pilots

Fixed No The rationale is the same as for the flight attendants. It is possible in the long run to save their salaries, but probably not in the short run.

Fuel Variable Yes The fuel will not be used, and therefore will be saved.

Food and drink given away on the flight

Variable Yes There will be no passengers to eat the snacks and drink the sodas.

Aircraft depreciation

Fixed No The aircraft will be used elsewhere. However, in the long run, it is likely that Delta can reduce the number of aircraft owned if the flight is permanently dropped.

Advertising Fixed No Advertising is probably not aimed at a particular flight.

Baggage handling

Fixed No This is another cost that might be saved in the long run if Delta permanently drops the flight, but is not saved in the short run.



Entrepreneurial Decision — BTN 23-7

1. Deluxe Premium

Selling price per unit ..................................................... $ 70 $ 90


Contribution margin per unit ........................................ $30 $40

Processing hours to produce 1 unit (carton) .............. 1 2

Contribution per processing hours (contribution margin per unit/[hours per unit]) ............... $30 $20

Sales Mix Recommendation. To the extent allowed by production and market constraints, Charlie should produce as many Deluxe brownies as possible. With a capacity of 400 hours of processing time per month, the company can produce 400 cartons of Deluxe brownies, computed as: Max. output of Deluxe = = 400 cartons per month Contribution Margin at Recommended Sales Mix Contribution margin = 400 cartons x $30 per carton = $12,000 per month 2. Sales Mix Recommendation with Sales Constraint. Charlie should make 60 cartons of Deluxe brownies to exactly match expected demand, and commit the remainder of its productive capacity to Premium brownies. This is computed as follows: Deluxe brownies .................................................................. = 60 cartons per month

Hours per carton ................................................................. 1.0 Hours used for Deluxe brownies ....................................... 60 hours Hours left for Premium brownies (400 hrs - 60 hrs) ............... 340 hours

400 hrs. per mo.

1.0 hrs. per carton



Entrepreneurial Decision (continued)

The output of Premium brownies with 340 production hours is Premium food = = 170 cartons per month

Contribution Margin at This Sales Mix


From Deluxe brownies ........................................ 60 $30 $1,800 From Premium brownies ..................................... 170 40 6,800 Total contribution margin ................................... $8,600

340 hrs. per mo.

2.0 hrs. per carton



Hitting the Road — BTN 23-8

Costs that must be considered: Costs of the ingredients, labor costs to

prepare the item; additional equipment needed to produce the item;

costs of training personnel to prepare the new item; costs of new

packaging required; costs of reformatting the cash registers to accept

the new item.

Nonfinancial items to be considered: Whether the new product will

enhance the current menu; consumer acceptance of the new item; lost

sales from current products if customers change from regular products;

competitors’ reaction to the new product.

Global Decision — BTN 23-9

There are probably several reasons why KTM would take on this project.

One reason is that the lower ongoing packaging costs can generate some

improved ongoing cash flows. KTM also probably feels a responsibility to

society to be a good citizen. They may feel that it is the right thing to do,

but it also has the benefit that some customers may look upon the

company more favorably and be more inclined to buy KTM’s products.

quick studies

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